THE MARINER'S MUSEUM, ET AL. v. CITY OF NEWPORT NEWS

OPINION BY JUSTICE A. CHRISTIAN COMPTON
FROM THE CIRCUIT COURT OF THE CITY OF NEWPORT NEWS

W. Park Lemmond, Jr., Judge Designate
Present: All the Justices

This is an appeal from a judgment in an action for relief from
alleged erroneous assessment of local taxes. The central issue is
whether a charitable corporation, eligible for an exemption from
real estate taxes, forfeits that exemption when it leases realty
to another charitable corporation and the lease is "a source
of revenue or profit" to the lessor under Code ? 58.1-3603(A).

In July 1994, appellants The Mariner’s Museum and Riverside
Healthcare Association, Inc., filed against appellee City of
Newport News an application, pursuant to Code ? 58.1-3984, for relief from
erroneous tax assessment. The plaintiffs asserted they are
nonstock, nonprofit corporations exempt from taxation. They also
asserted the Museum owns real estate located in the City that is
leased to Riverside, which occupies and uses the property
exclusively as a hospital conducted not for profit.

The plaintiffs alleged that the City erroneously has assessed
the Museum for real estate taxes and that Riverside (the
Hospital) has paid the taxes on behalf of itself and the Museum
under protest. They asked the court to enter an order declaring
the tax assessment erroneous, invalid, and illegal, and
exonerating the plaintiffs from any liability for payment of the
taxes. They also sought a refund in the amount of approximately
$2.8 million with interest.

Responding, the City denied the plaintiffs are entitled to the
relief sought. It asserted "that the aforesaid real estate
is leased or was otherwise a source of substantial revenue or
profit" to the Museum and, accordingly, it is liable to
taxation pursuant to Code ?
58.1-3603.

The parties entered into a stipulation of facts and submitted
the case to the trial court on issues of law. Following argument
of counsel, the court, in a letter opinion, denied the
plaintiffs’ application for relief. The plaintiffs appeal from
the February 1997 final order adjudicating that the taxes in
issue had not been erroneously assessed.

According to the stipulation, the Museum was organized in 1930
to operate, in what is now the City of Newport News, "a
museum and library pertaining to nautical subjects" and
"otherwise to advance learning, the arts and sciences
relating to or bearing on water craft, the marine and marine
navigation." The Museum is owner of a substantial amount of
realty located on the east and west sides of Warwick Boulevard in
the City, and has leased a part of the property on the east side
to the Hospital and its predecessor corporation. The plaintiffs
are exempt from taxation of their income pursuant to the federal
Internal Revenue Code.

Since February 1963, a medical center known as Riverside
Hospital has been operated on the land leased from the Museum.
The Hospital always has been conducted not for profit and
exclusively as a charity. All buildings, parking lots, and
related structures are used by the Hospital for charitable,
literary, scientific, or educational purposes.

Over the years, the Hospital has expanded existing structures,
constructed additional buildings, and leased more property from
the Museum as its hospital operations have grown. In September
1989, the Museum and Hospital entered into a lease superseding
all prior leases. In 1990 and 1993, construction of additional
hospital facilities was completed on the leased property.

The September 1989 lease covers about 36 acres and is for a
term ending on December 31, 2061. It provides that the Hospital
is leasing the property "for the purpose of conducting its
medical facilities and such other allied purposes."

The total rent for the 72-year term is $5 million, with $2
million to be paid upon execution of the lease, $2 million in
January 1990, and $1 million in January 1991. These sums were
paid in a timely fashion.

In an April 1994 letter, the City’s Chief Assessor notified
the Museum that "it has been determined that the land that
was the subject of the 1989 lease is no longer exempt from
taxation pursuant to the provisions of" Code ? 58.1-3603. Prior to April
1994, no effort had been made by the City to assess real estate
taxes against any land covered by the several leases between the
parties. The letter enclosed "the assessment for the current
tax year and the three (3) most recent tax years." This
action ensued.

Settled principles applicable here should be reviewed. The
general policy in the Commonwealth is to tax all property. See
Va. Const. art. X, ?
1. But the Constitution creates certain exemptions, seeid.? 6(a), and authorizes
the General Assembly to establish others. Seeid.? 6(b). And, the legislature
is permitted to restrict or condition, in whole or in part, but
not extend, any or all of the exemptions created in the
Constitution. Id.?
6(c).

Furthermore, the Constitution provides that all exemptions
shall be strictly construed against the taxpayer. Id.? 6(f). "Under this
rule, exemption from taxation is the exception, and any doubt is
resolved against the one claiming the exemption." DKM
Richmond Assocs. v. City of Richmond, 249 Va. 401,
407, 457 S.E.2d 76, 80 (1995). The burden is upon the taxpayer to
establish that it comes within the terms of the exemption. Id.

The Constitution authorizes the General Assembly to exempt
from taxation property used by its owner for charitable,
historical, benevolent, or cultural purposes "subject to
such restrictions and conditions as may be prescribed." Art.
X, ? 6(a)(6).

The General Assembly implemented the foregoing constitutional
provisions in Title 58.1, Chapter 36, of the Code. "Property
of any nonprofit corporation organized to establish and maintain
a museum" is exempt by classification from taxation. Code ? 58.1-3606(A)(8).

However, ?
58.1-3603, the main focus of this appeal, restricts exemptions
under certain circumstances. The statute provided at the time of
this dispute that: "Whenever any building or land, or part
thereof, exempt from taxation pursuant to this chapter . . . is
leased or is otherwise a source of revenue or profit, all of such
buildings and land shall be liable to taxation as other land and
buildings in the same county, city or town." ? 58.1-3603(A) (1991 Repl.
Vol.). The statute further provided: "In assessing any
building and the land it occupies pursuant to subsection A, the
assessing officer shall only assess for taxation that portion of
the property subject to any such lease or otherwise a source of
profit or revenue . . . ." ? 58.1-3603(B) (1991
Repl. Vol.) (statute amended in part by Acts 1996, ch. 534).

On appeal, the plaintiffs claim that the trial court
"reached its decision that the subject property was not
exempt from taxation based solely on the provisions of Section
58.1-3603." The plaintiffs note the court concluded that the
payment of $5 million as consideration for the 1989 lease
constituted "revenue or profit" within the meaning of
the statute and that the property therefore was not exempt.

Continuing, the plaintiffs argue that the decision below was
reached "without regard for" certain provisions of the
Constitution of Virginia "as it existed both before and
after its amendment in 1971, other provisions of the Code of
Virginia which deal with the subject of tax exempt property, and
a decision by this Court which is on all fours with the case at
bar." Concluding, the plaintiffs contend the judgment of the
trial court "was contrary to the law and the evidence and
should be reversed." We disagree.

The existence of the 1989 lease between the Museum and the
Hospital has been stipulated. However, the mere existence of a
lease will not work a forfeiture of the exempt status that the
leased property may otherwise enjoy. Board of Supervisors of
Wythe County v. Medical Group Found., Inc., 204 Va.
807, 812, 134 S.E.2d 258, 262 (1964). Rather, the lease must
generate a "substantial" net revenue or profit before
the exemption is forfeited. SeeCity of Newport News
v. Warwick County, 159 Va. 571, 593-94, 166 S.E. 570, 578
(1932).

In the present case, as the trial court found, the 1989 lease
generated a substantial net revenue or profit. The lease yielded
$5 million in revenue for the Museum during the first 16 months
of its term.

Under the lease, the Museum incurs no expenses for the leased
property. For example, Section Eight of the lease provides:
"It is the intent of the parties that the Lessee is to pay
all charges and expenses of every nature that may be imposed upon
the Premises and its appurtenances in any manner during the term
of this Lease and that may arise during the term of this Lease
from the use and/or misuse of the Premises in any manner."

Therefore, we hold that the Museum’s receipt of a substantial
net revenue or profit from the lease to the Hospital renders the
otherwise exempt property taxable under ? 58.1-3603.

The plaintiffs rely heavily upon the Wythe County case,
which, they say, "is on all fours with the case at
bar." That case is not controlling. Actually, it supports
the trial court’s ruling in this case.

In Wythe County, decided under ? 183 of the 1902
Constitution, before adoption of the current 1971 Constitution,
the Court considered a real estate tax exemption involving a
lease between two charitable corporations. The first issue was
whether the realty owned by one charitable corporation and leased
by it to another charitable corporation to be operated as a
hospital, exclusively as a charity, was property "belonging
to" the lessee within the meaning of a constitutional and
statutory provision, so as to affect the tax exempt status of the
property. 204 Va. at 808, 134 S.E.2d at 259. The "belonging
to" phrase now appears in Code ? 58.1-3606(A)(5).

The term of the lease was 15 years, with a right of renewal,
at a monthly rental of $2,400. The rent was an amount that the
lessor anticipated would be required to curtail a $100,000 loan,
obtained to fund construction of the hospital building, and to
meet expenses of equipping the hospital. Id. at 809, 134
S.E.2d at 259. The lessee encountered financial difficulties and
the lessor wrote off some of the amounts due it under the lease,
refinanced the loan, and negotiated a new 15-year lease at a
monthly rental of $2,500, the amount needed to amortize the
refinanced mortgage. Id., 134 S.E.2d at 260.

This Court held that the subject property "belonged
to" the lessee, "so long as it has the exclusive right
to its possession under the lease," id. at 812, 134
S.E.2d at 261-62, and hence was qualified for exemption.

The first issue in Wythe County, of course, is not
presented in this case; the City always has conceded that, but
for the 1989 lease and the application of the provisions of Code ? 58.1-3603, all the
Museum’s property would qualify for exemption.

The second issue addressed in Wythe County, however, is
presented here. The Board of Supervisors contended that, even if
the hospital property were exempt, the exemption was lost by
virtue of the leases. The Board relied on a paragraph in ? 183 of the 1902
Constitution providing that exempted real estate shall be liable
to taxation whenever it "shall be leased or shall otherwise
be a source of revenue or profit." 204 Va. at 812, 134
S.E.2d at 262. Similar language now appears in Code ? 58.1-3603 ("a source
of revenue or profit, whether by lease or otherwise").

Focusing on the renegotiated lease, we held it did not affect
the tax exempt status of the hospital property. The Court
reasoned that the rent the lessee agreed to pay tended
"immediately and directly to promote the objects and
purposes for which the [lessor] was chartered. Indeed, the amount
to be received by the [lessor] under the lease was to pay on the
loan secured by the property in order to prevent a foreclosure
and assure the continued existence of hospital facilities. Thus
the lease . . . was not a source of revenue or profit." Id.
at 813, 134 S.E.2d at 262.

The Wythe County facts are not present here. Unlike the
lessor in Wythe County, the Museum, as we have said, does
realize substantial net revenue or profit from the lease. Indeed,
implicit in Wythe County is the conclusion that, but for
the fact the revenue received by the lessor was
"incidental," not substantial, the property would have
been taxable. Id. at 814, 134 S.E.2d at 263.

Additionally, there is no evidence that the $5 million rent
tended "immediately and directly to promote the objects and
purposes" for which the Museum was chartered. Certainly, one
may assume that any funds received by a museum will promote its
charitable purposes, a fact not in evidence here. But that makes
no difference because the Museum no longer uses its leased
property for museum purposes; it leases the land as a means of
generating substantial net revenue or profit. It is the use to
which property is put, not the use to which profits that are
realized from such property are put, that determines whether the
property shall be exempt. Commonwealth v. Trustees of
Hampton Normal and Agric. Inst., 106 Va. 614, 621-22, 56 S.E.
594, 597 (1907). SeeCounty of Hanover v. Trustees
of Randolph-Macon College, 203 Va. 613, 617, 125 S.E.2d 812,
815 (1962). This principle applies even though, as here, the
lessee of an exempt owner also enjoys a tax exempt status. SeeCommonwealth, 106 Va. at 621, 56 S.E. at 598.

The remaining issues raised by the plaintiffs merit only brief
comment. They point to a "grandfather clause" in the
1971 Constitution, which provides "that all property exempt
from taxation on the effective date of this section shall
continue to be exempt until otherwise provided by the General
Assembly as herein set forth." Va. Const. art. X, ? 6(f). See Code ? 58.1-3606(B) (certain
property exempt on July 1, 1971 shall continue to be exempt under
rules of statutory construction applicable to exempt property
prior to such date).

The plaintiffs argue the "subject property was clearly
exempt on July 1, 1971," the effective date of the present
Constitution, and the property "has continued to be exempt
until the present time pursuant to the current Constitutional and
statutory provisions." We do not agree.

This contention assumes the property was exempt in 1971, a
conclusion that is questionable given the evidence in this case.
And, the property was not rendered exempt merely because the City
did not tax the property prior to the assessments in issue here.

Even assuming the property was exempt in 1971, however, the
Museum is not eligible for protection under the grandfather
clause. The execution of the 1989 lease was a defining and
controlling event that operated as a forfeiture under Code ? 58.1-3603. Property
exempt under a 1971 grandfather clause does not remain
perpetually exempt regardless of post-1971 actions by the
property owner.

Finally, we reject the plaintiffs’ contention that the subject
property is exempt under portions of Code ? 58.1-3203, which deals
with taxation of leasehold interests. This case does not involve
leasehold taxes. Therefore, the statute is inapplicable.

Consequently, we hold that the plaintiffs failed to carry
their burden to show they qualify for the tax exemption, that the
City properly imposed the taxes upon the Museum, and that the
trial court did not err in denying the plaintiffs’ application
for relief. Thus, the judgment below will be